Many Americans are drowning in debt. Consumer debt hit $16.51 trillion at the end of 2022, and the average American owed $92,727 when mortgages, student loans, auto loans, personal loans and other debts were tallied, according to a Bankrate analysis of Experian data.
If you’re feeling pressured to keep up with debt payments, you may be wondering if loan consolidation is right for you. Here’s a look at how it works, key factors to weigh and, if you’re married, whether you and your spouse should consolidate your debts into one loan.
Consolidating debts generally means taking out a loan at an attractive interest rate and using it to pay off debts. People usually use debt consolidation for high-interest debt rather than for lower-interest debts, like a mortgage or federal student loan.
Some people opt to get a loan at a more favorable interest rate from a family member or borrow from their home equity line of credit. Others with more troubled credit histories may not have these options and instead take out a personal debt consolidation loan.
Pros and Cons
Rolling debts into a lower-interest loan allows you to get ahead by making the same size payments every month because, when the interest is lower, less of the money you’re paying back goes toward interest and more goes toward the principal.
There are other advantages as well, such as having only one monthly payment instead of several. “It can simplify things for you,” says Lacey Langford, an accredited financial counselor and founder of the Military Money Expert, a financial coaching firm in the Greensboro/Winston-Salem area of North Carolina.
But there are downsides too. If your debts each have different interest rates, you’ll need to do the math to make sure that consolidation in a new loan will save you money in the end. There’s also a cost to consolidation, whether it’s transfer fees or fees associated with the new loan.
And then there’s the matter of paying off the new consolidated loan. While before you could chip away at some of the debt with smaller payments of $25, $50 or $100, you’ll now have to make one larger payment regularly, says Rahkim Sabree, a certified financial education instructor and financial coach based in the Greater Hartford area.
What Couples Should Keep in Mind
If you’re part of a couple, you may be thinking about consolidating your debts with your partner’s debts. However, most experts caution against this—even if your other finances are blended—in case one of you experiences an unforeseen event, like a lawsuit, that affects your credit profile. In addition, both of your credit scores can be affected, even if one person built up the bulk of the debt.
Furthermore, if you entered a marriage with a little bit of debt and your spouse has a lot, and you end up getting divorced, you could find yourself liable for paying off debts you didn’t incur personally.
An Alternative to Debt Consolidation
If it’s legal in your state, you might consider debt settlement. With this option, you enter a program in which a professional, such as a lawyer, renegotiates your debts and repayment terms. There are some unscrupulous providers in this space, so look for someone who is licensed with your state department of finance, advises Leslie Tayne, a debt consolidation attorney at Tayne Law Group.
“Go with your gut,” she says. “If you don’t feel comfortable with someone, don’t feel pressured to move forward with them.”
Keep in mind that when debt is canceled, the amount forgiven is generally considered taxable by the IRS. However, if your total debts exceed your assets, an experienced attorney, working with tax advisors, can mitigate the tax implications by two different actions: filing an insolvency form and spreading out the forgiveness over several tax years, says Tayne.
Reflect on How You Got in Debt
Regardless of how you tackle your debt, it’s important to take some time to understand how you got into debt in the first place. “The challenge of consolidating debt is not only doing it, but having a plan in place so it doesn’t happen again,” says Heather Holjevac, a financial planner at Holjevac Financial Group.
If your expenses exceed your cash flow, you’ll need to make some adjustments, such as earning more money or cutting back on spending.
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Elaine Pofeldt is an independent journalist who specializes in careers and entrepreneurship. She is the author of The Million-Dollar, One-Person Business, and her work has appeared in Fortune, Money, CNBC and more.